I will soon be transferring a Roth IRA and a Traditional IRA to Vanguard. Both of these accounts have pretty minimal amounts in them. I am 26 years old, and will be contributing $3,000 to my Roth IRA each year. I am now struggling with how much diversification I should have in each of my IRA accounts.

At this point I was thinking about the S&P 500 index fund for the TIRA and the Total Stock Market index fund for the Roth IRA.

Should I be diversifying more within my Roth IRA, like adding some bond funds or international index funds?

I have 2 401ks (previous and current employer), and 2 ROTHs (mine, my wife's). My approach has been: its all for retirement, so the total should be diversified. Any one account is not diversified, but the sum of all of them is.

If you try to diversify all of your accounts individually, you will have higher trading costs when you rebalance.

I would suggest grouping accounts by investment horizon, and trying to have good diversification for similar accounts. So the total of all your retirement accounts would be diversified as one. And shorter term investments (college savings plan, etc), if any, would be diversified separately.

Since you are only 26 and this is retirement money, you don't need bonds at this point so long as you don't mind riding out market downturns. Over the next 30 - 40 years you're almost certain to see a couple periods like 2000-2002. If you can deal with that and still sleep at night, you can leave everything in stocks. Your plan looks sound. As you get older you can gradually shift some of the money over to a bond index for diversification. Congratulations on getting an early start on retirement savings.

I agree with previous posters ideas on diversification. They are right on.

At age 26 and for small account balances, S&P 500 and Total Stock Market Index are diversification enough for now. I would not own bonds for now until 1) you get within 10 years of retirement or 2) you have in mind some other short term use for the money such as downpayment on a house or education of your children. Otherwise, stay in equities and keep your money growing as best you can.

Once your account balances get into the years of pay range, then you might think about broadening out a bit, buy some other funds in addition or some individual stocks. But for now, don't worry about it.

Thank you all for your input. I have already purchased a home, and there are no children in the picture for the near future - so I will just keep all of my money in equities until there is a need for something else.

At this point I was thinking about the S&P 500 index fund for the TIRA and the Total Stock Market index fund for the Roth IRA.

I agree with RookieJoe's statement:

So the total of all your retirement accounts would be diversified as one

You should always look at your portfolio as a whole, not in account pieces. I don't know why you're choosing both the S&P500 index and the Total Stock Market index. Since the TSM index is cap-weighted it is weighted toward the S&P500 stocks anyway. Compare the performance of these two funds and you will see how closely they track to each other. I myself prefer the TSM index because it gives you at least some exposure to mid and small-caps.

Should I be diversifying more within my Roth IRA, like adding some bond funds or international index funds?

Like the other posters, I think you're too young for bonds, and IMHO they won't be doing too well in the near future anyway. As to the international index fund: Decide what percentage of your TOTAL portfolio, (i.e. 10%) you are willing to place in a higher risk/higher return category, then buy the corresponding dollar amount in an international index fund. It doesn't matter which account (Roth or TIRA) you buy it in--although the Roth might be better since that's the one you'll be adding to in the future and it will make rebalancing to 90% TSM index, 10% international index easier in the future. (The 90%/10% is just used as an example--decide on your own percentages.)

In summary, decide what percentage you want in international, and buy that in one of the accounts (probably the Roth). Then buy the TSM index fund with the remaining funds in that account, and also in the other account. Forget the S&P500 index fund--it's redundant.

You might also want to visit the Index Fund board and see what they have to say about the S&P500 and the TSM index:

Do the rest of you adjust (based on expected tax rate) for whether or not the holdings are in a tax deferred account, or a tax free account?

Just as an example, if one has 10k in domestic stocks in a traditional IRA, and 10k in foreign stocks in a ROTH IRA… The effective allocation is not really 50% domestic / 50% foreign. In my mind, the only dollars that matter are the after tax dollars that go in my pocket. So if the expected tax rate during retirement is 25%, the allocation is really 43% domestic / 57 % foreign.

I use a spreadsheet to break my funds down into about 10 asset classes, then sum each of the asset classes and calculate percentages. I've considered adding in a multiplier to the spreadsheet to adjust everything into after tax dollars.

rookieJoe: "Do the rest of you adjust (based on expected tax rate) for whether or not the holdings are in a tax deferred account, or a tax free account?"

No. Do you know what your tax rate will be when you retire. Congress has played around with rates so many times, that I would not alter my basic allocation based solely upon future expected tax rate.

"Just as an example, if one has 10k in domestic stocks in a traditional IRA, and 10k in foreign stocks in a ROTH IRA… The effective allocation is not really 50% domestic / 50% foreign. In my mind, the only dollars that matter are the after tax dollars that go in my pocket. So if the expected tax rate during retirement is 25%, the allocation is really 43% domestic / 57 % foreign."

Effective rate of marginal rate? Accuracy of expected tax rate in retirement? What happens when Congress changes the law and makes Roth IRAs into equivalent of traditional IRA with after tax dollars -- basis equals contributions, taxes on withdrawals based on allocation of basis.What if FIT is abolished and a national sales tax is added, a la FairTax?

I believe that you are making your life more complicated then need be based on predications that are too difficult to make accurately.

Just as an example, if one has 10k in domestic stocks in a traditional IRA, and 10k in foreign stocks in a ROTH IRA… The effective allocation is not really 50% domestic / 50% foreign. In my mind, the only dollars that matter are the after tax dollars that go in my pocket. So if the expected tax rate during retirement is 25%, the allocation is really 43% domestic / 57 % foreign.

That's true, but if you're comparing apples to apples and taking taxes into consideration, you should compare both investments on a pretax basis. You put 10k into the TIRA pretax. But your $10K Roth IRA was about $13k pretax assuming a 25% tax rate. So your Roth allocation is, after taxes, > 50%, but you contributed more to it in the first place.

As it stands now, I agree that your example is weighted more than 50% in foreign stocks.

I believe that you are making your life more complicated then need be based on predications that are too difficult to make accurately.

Regards, JAFO

I agree with JAFO--tax rates change almost as often as presidents. Right now taxable accounts seem more desirable to some folks because of the lower cap gains taxes--but that's only good for another 4 years (if that), a relatively short time in the realms of investing. Thirty years ago the max cap gains rate was, if I'm not mistaken, 36%! So, if your retirement time horizon is 30 years away, it's anyone's guess what will have happened to incremental ordinary income tax rates, cap gains rates, ROTH rules, TIRA rules, etc. They might in the future decide that if an individual's income in retirement is above a certain level, that individual should pay tax on their Roth withdrawals--who knows?

Another thing to consider is the complexity of what you're undertaking. The example you used is probably the simplest of comparisons (Roth and TIRA), but what happens when you start dealing with taxable accounts, in which you're only taxed on the gains, not your basis, and at what rate would you estimate the cap-gains tax, short or long-term? What about the Alternative Minimum Tax? What happens if you become non-eligible for a Roth, but decide to make non-deductibe contributions to a TIRA--you'd have to track the gains separately so that you could apply your estimated tax rate to the gain portion only and not the basis. In addition, as another poster pointed out, if you're now counting on an 'after-tax' basis, you have to consider the extra cost of the ROTH contributions in your calculations, or conversely the lesser cost of the TIRA contributions, which also means you'd have to track contributions and gains separately because the after-tax cost of each is different in the TIRA account.

For someone with 5 different types of accounts that will each be taxed differently in retirement, trying to allocate on an 'after-tax' basis would be a nightmare. You might be in this position 20 years from now. Why complicate your life unnecessarily?